Imagine borrowing money more cheaply because the rest of the world wants your currency.  Better still, imagine buying imported goods more cheaply while enjoying enormous financial influence around the world.

Nice work if you can get it. And America can.

For decades, the US dollar has sat at the centre of the global financial system. This position gives the United States what has famously been called an “exorbitant privilege.”

And it certainly looks like one. But privileges sometimes come with fine print.

What if the same system that gives Americans cheaper imports also makes life harder for American manufacturers? What if easier government borrowing also makes it easier to keep borrowing?

Suddenly, the privilege becomes much more interesting.

That link to gold eventually disappeared, but the dollar’s dominance didn’t.

Central banks still hold vast amounts of dollars. Commodities are commonly priced in them, while international debts are often denominated in them. Businesses across the world also use dollars to settle transactions.

When the world wants dollars, it also needs somewhere to put them.

Enter US Treasury securities.

The United States has one of the world’s deepest and most liquid financial markets. Governments, central banks and investors can park enormous amounts of money there.

For America, that’s a rather enviable arrangement.

Global demand for US assets helps the government borrow more cheaply than it otherwise could. A strong dollar can also make imported goods cheaper for American consumers.

Then there is the geopolitical clout. So much international finance passes through the dollar-based system that access to dollars and dollar banking matters enormously. This gives the United States considerable influence over global financial flows and makes financial sanctions a powerful weapon.

Cheaper borrowing and cheaper imports, combined with considerable financial power. You can see where the “exorbitant privilege” comes from.

Now for the fine print.

That’s lovely if you’re an American buying a television made overseas because your dollar buys more. But imagine you’re an American manufacturer trying to sell machinery overseas.  Suddenly, those expensive dollars aren’t quite so lovely.

A stronger dollar makes American goods more expensive for foreign buyers. At the same time, imported goods become cheaper for Americans.

The consumer can win while the manufacturer struggles.  That’s an important ‘dot’.

And economists have been wrestling with a version of this problem for decades. It even has a name: the Triffin dilemma.

In simple terms, the country supplying the world’s dominant reserve currency must also provide enough of its currency and financial assets to meet global demand. Over time, the needs of the global financial system can conflict with what’s best for the country’s domestic economy.

That’s the dilemma. The world wants dollars, but satisfying that demand can create pressures at home.

That creates enormous international demand for US Government debt and helps keep borrowing costs lower. Clearly, that’s an advantage, but cheap borrowing has an awkward habit of encouraging more borrowing.

Reserve currency status didn’t cause America’s debt problem. Government spending and taxation decisions matter enormously.

But the privilege does make that debt easier to finance. When borrowing is easier, the pressure to stop borrowing can be weaker.

America’s trade deficits, manufacturing decline, government debt and the strength of the dollar are often discussed as separate issues. They aren’t.

Capital flows affect the dollar, and the dollar affects trade. Trade affects manufacturers and consumers. Global demand for US assets affects borrowing costs, which in turn influence debt.

Pull one thread and something moves somewhere else.

None of this means reserve currency status caused America’s manufacturing decline. Automation, globalisation, labour costs, productivity, trade policy and the rise of China have all played important roles.

Nor does it mean America would be better off without the dollar’s dominant position. Losing it suddenly could be enormously disruptive.

The point is more interesting than that.

One of America’s greatest economic advantages may also contribute to some of the problems America is trying to solve.

Could Anything Replace the Dollar?
Predictions of the dollar’s demise have been around for years.